The recent plunge in the Chinese stockmarket has shown investors that emerging markets can go down as well as up. The slump in commodity prices is hitting resource-rich countries, such as Russia. Meanwhile, there are fears that an increase in US interest rates could tempt investors to bring their money back to America. So it’s not surprising that the MSCI Emerging Markets index has fallen by 25% in US dollar terms since April.
But there are still solid reasons for investing in emerging markets. Taken as a whole, developing economies are growing faster than the developed world. They also have better demographics than the ageing populations of Europe, Japan and America. Finally, they are cheaper.
Star Capital, an investment manager, estimates that emerging markets have an average cyclically adjusted price/earnings ratio (Cape) of 13.7 and a dividend yield of 3.2%, compared to a Cape of 20.2 and yield of 2.6% for developed markets. Comparing these valuations with their historical averages, it predicts that emerging markets will outperform developed markets by 3% per year over the next 15 years.
So what’s the best way to invest in emerging markets? The main UK-listed exchange-traded funds (ETFs) are the iShares Core MSCI Emerging Markets IMI UCITS ETF (LSE: EMIM) and the Vanguard FTSE Emerging Markets (LSE: VFEM), both of which have a total expense ratio of 0.25%. China is the largest holding in both funds (through Hong Kong-listed Chinese companies), accounting for around a quarter of both funds.
The main difference between them is that South Korea is the second-largest holding in the iShares fund (at 15%), but does not feature inthe Vanguard fund (because FTSE classes South Korea as a developed market). Other major holdings in both ETFs include Taiwan, India, South Africa and Brazil.
In terms of active funds, Templeton Emerging Markets Smaller Companies Fund, which is co-managed by legendary investor Mark Mobius, has beaten the MSCI Emerging Markets index by a substantial amount over the last two years. It has an annual charge of 1.65% for the “W” share class available through major fund supermarkets (the older “A” share class has a higher annual charge of 2.5%).
Another strong performer in recent years is the JP Morgan Emerging Markets Small Cap Fund, run by Amit Mehta, which has a relatively large exposure of more than 30% to consumer goods stocks. The “A” share class has an annual charge of 1.8%.